Natural gas has a place in portfolio, argues Schroders’ Simon Webber

Simon Webber, co-manager of the Schroder Global Climate Change fund, says natural gas remains one of the keys to solving the challenge of future energy needs.

In theory we could quickly move to a world where all our electricity needs are provided by wind, hydro and solar electricity, supported by large amounts of battery storage to provide power when there is little wind or sun. However, as desirable as this may sound, such a solution is just not economically viable.

Why clean energy can’t go it alone yet

Clean energy faces challenges – it will require $6trn in investment to replace 3,000 GW in global fossil fuel-based power plants with renewables, and in addition trillions of dollars are needed for storage capacity. Consumer electricity prices would be pushed sky high and many more people around the world would be pushed into fuel poverty. These factors would in turn undermine public support for making a transition of any kind towards clean energy. In the UK there are already rising concerns in political circles about the likely public backlash towards the low carbon agenda when the high cost of building offshore wind and new nuclear is factored into bills over the next 10 years.

This is why gas is so important. Achieving decarbonisation of the electricity sector is a highly complicated task, but major (and more affordable) steps can be made by steadily growing the contribution of renewables while using gas to phase out oil and coal based generation.

Gas as a stepping stone

The massive shift to a low carbon energy system needs to be achieved with a steady mix shift towards true low emission energy technologies; wind, solar, nuclear, hydro. This must be complemented by the most efficient and flexible fossil fuel-based generation, which is gas based.

Gas is clearly not the end ‘solution’ for climate change mitigation as it still produces greenhouse gases. However, emissions are significantly lower than burning coal or oil. Compared to average emissions from coal-fired generation, natural gas produces half as much carbon dioxide, less than a third as much nitrogen oxides and one percent of the quantity of sulphur oxides.

Modern gas power plants can ramp up and down much more quickly than coal, oil, or nuclear power plants, making them the best complement to intermittent renewables. The marginal cost of producing wind power is actually close to zero and as such will always be the first power source to be dispatched onto the system. Gas power merely allows us to deal with peak demand and (with sufficient capacity allowances for the capital cost) are complimentary to renewables in the mitigation period. Gas is certainly not the ultimate solution unless it is implemented with Carbon Capture. However, this can be done in time, or alternatively gas can be phased out further in the future.

Answering the critics

One argument often cited by critics is that cheap gas-based power reduces the incentive to build renewables. However, in most parts of the world gas is expensive: much more expensive than coal in fact, and hence actually provides an incentive to deploy renewables.

Only in the US has abundant shale gas supply led to rock bottom prices. Cheap US gas prices have, though, had the positive effect of massive coal to gas switching. We should welcome this as many of the coal-based plants will not come back online again, leading to a cleaner overall system when gas prices do normalise. This fuel switching has also led to the first major non recession-induced declines in US greenhouse gas emissions; this, after all, is the objective here.

Another argument against gas highlights that shale gas leads to plentiful fugitive emissions while being extracted. This is a red herring, however, as there is no reason why – with the right care, regulation and technology – these fugitive emissions cannot be minimised. Well managed shale gas operations do not waste gas if they can help it, and the data in North America do not support material wasteful fugitive emissions.

Investment implications

So in our view, gas should clearly be the fossil fuel of choice, where necessary, over the next 20 years. Gas growth should come at the expense of coal and oil, not renewables, and it is easy enough for regulators to provide the necessary framework and incentives to ensure this happens.

The real issue when valuing gas companies is to decide whether towards the end of that 20 year timeframe the world really will get serious about moving to a truly low carbon economy and start phasing out gas, or investing to capture its emissions, another expensive endeavor.

The reality is that if climate change is to be successfully mitigated, the global carbon budget (total allowable greenhouse gas emissions through 2050) implies that equity markets are overcapitalising the reserves and resources of the whole fossil fuel industry.

 

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